Covid-19 and the Extent Of Contracts Enforceability: Impact on Commercial Contracts

Shubham Gupta, 4th year law student, Nirma University

Introduction

With an unprecedented turn of events in the wake of COVID -19, the enforceability of contracts have become a major lookout. Giants such as Inox Leisure Ltd., PVR, Cinepolis are invoking the Force Majeure [“FM Clause”] in their contracts for subduing the rental obligations to their landlords.[1] COVID-19 has caused serious market disruptions and financial dislocations. The basic assumption is that there is a fundamental change in market circumstances due to the uncertainty of an outbreak, and there is a persisting problem until the extenuation of the disease.

In this light, it is pertinent to administer, whether a party can invoke the doctrine of frustration under Section 56 of Indian Contract Act [“ICA”] or the FM clause; if yes, under what set of circumstances shall this be invoked.A claim to avoid adherence to legal obligations in the contract can be fundamentally challenged on various grounds. Parties may seek to invoke the FM clause on the primary grounds of impossibility due to the unforeseeable COVID-19 outbreaks. Yet another ground that can be invoked is the performance of the contract to be commercially impractical or fundamentally expensive to further avow the contract

The Doctrine of Frustration under the ICA and Impossibility

Section 56 of the ICA, 1872 states an agreement to do an act which has become impossible or unlawful to be void. Unlike the common law jurisprudence which confides in different theories like just and reasonable principle,[2] construction,[3] multi-factorial approach,[4] it enunciates positive rules for the frustration of a contract.[5] This doctrine is applicable when a supervening event happens which was unexpected, beyond the control of the parties leading to an impossibility performance of the contract.[6] In the seminal case of Satyabrata Ghose v MugneeramBangur and Co,[7]   impossibility is the second paragraph of Section 56 as interpreted,‘[T] he performance of an act may not be literally impossible, but it may be impracticable and useless from the point of view of the object and purpose which the parties had in view. Therefore, if an untoward event or change of circumstances totally upsets the very foundation upon which the parties rested their bargain, it can very well be said that the promisor finds it impossible to do the act which he promised to do.’[8]This understanding creates a contrast with the wordings of Section 56 of the ICA. Section 56, paragraph 2 envisages the discharge of contract by two reasons – first, impossibility, and second illegality by reason of any event which the promise could not prevent. In the latter condition, illegality arises due to faults that are within the control of a party, whereas; the former condition does not prescribe such the same. This leads to an immaculate understanding of the non-enforceability of a contract if performance has been rendered impossible due to the party’s fault. However, this isn’t in conformity with the subsisting position. Self-induced frustration cannot be a ground to avoid contractual obligations.[9] However, this interpretation can be simulated in illustration 5 of Section 56;Illustration 5: A contract to act at a theatre for six months in consideration of a sum paid in advance by B. On several occasions A is too ill to act. The contract to act on those occasions becomes void.This illustration elucidates an understanding that due to self-incapacitation, the contract shall deem to be void. Hence, a sharp divergence from the literal interpretation of Section 56 can be noted down.Further, any change of circumstances cannot be considered an ipso facto ground for avoiding contractual obligations. The landmark case of Alopi Parshad & Sons Ltd, v Union of India[10]held that a contract is not frustrated merely because circumstances have changed. The court’s power to dissolve a contract under Section 56 is limited in its scope. The contract is not frustrated until the fundamental basis of the contract is changed,[11] and is radically different from the existing circumstances.[12]

FM Clause and Impossibility

The Courts have applied the doctrine of frustration restrictively, and thus, are reluctant to discharge a party from adhering to the contract.[13] In Paradine v Jane,[14] the court held that usually contracts are not discharged by any frustrating event, and if such a scenario would have existed, the parties must have included such eventualities in their contract. Therefore, to averse the risk, which is unforeseen and beyond the reasonable control of human, the parties devise mechanism like the FM Clauses. It should properly be inserted in a contract. Omissions of inclusion of such provisions will render the incurrence of liability.The FM clause seeks to anticipate unforeseeable eventualities and settles the allocation of risks beforehand rather than in an imposed manner.[15] Even after having a close affinity with the common doctrine, it is very narrowly interpreted in its relieving effect.[16] It doesn’t include the acts of negligence, omission, or default of the contracting party.[17]For an event to qualify as an FM, the event preventing performance must be unforeseeable and irresistible.[18] If there is an alternative way to perform obligations, even after the dramatic change in market circumstances, such would not qualify to invoke a Majeure clause.[19] In Palmco Shipping Co. v. Continental Ore Corp., [20] unavailability of the Suez Canal route cannot tantamount to frustration if goods can be transferred via the Cape of Good Hope. There should be a direct link between the supervening event and the impossibility of performance.In India, an FM can be traced back to Section 32 which stipulates the impossibility of rendering performance on the ground of an uncertain and unforeseeable future event becomes impossible. Impossibility can be interpreted as the deviation of the basic foundations on which the contract was agreed upon.[21] Commercial Impossibility is not within the purview of impossibility.[22]Since, COVID-19 is an unprecedented outbreak that has ravaged businesses, including stock exchanges meeting circuit breaks, it is forcing Govt. to impose nationwide lockdown which soars contractual obligations across the world owing to commercial hardships. Therefore, it is quintessential to culminate meaning from the construction of the contract through language and wordings.[23]

Covid- 19 and FM : A tale of uncertainty

To ascertain whether COVID 19 is an FM event or not, the actual result would depend on the contractual context and intention of the parties.In 2003 SARs in an epidemic-related case Li Ching Wing v Xuan Yi Xiong,[24] a tenant claims that the tenancy agreement is frustrated owing to an isolation order issued by the Govt. for which a tenant could not be inhabited for 10 days. The Court held the SARS epidemic to be an unforeseeable event, and, 10 days are insignificant to claim frustration in a two-year lease agreement. Similarly, even though, COVID-19 is an unforeseeable and a supervening event, it is assumed to be temporary in nature, thus, it is highly unlikely that frustration can be claimed within the framework of Section 56 of the ICA. Rather, if a contract contains an FM clause containing specific inclusions like a pandemic, and epidemic expressly, or by necessary implication, the contractual obligations may be suspended for a while. For instance, if the theatres are facing closure owing to lockdown orders, it would be safe to invoke the FM clause in their agreement with the landlords to suspend their legal obligation to pay rent till the outbreak continues.However, the drafting of these FM clauses assumes an understanding to incorporate this specific exclusion within its scope. The burden of proving for establishing the FM clause rests on the party who invokes it.[25].  

Effectively, in severity and unusual nature of events, the burden would be wrapped under the general context of the contract unless a specific clause is directed towards a different event. Therefore, the burden would be on the parties to establish that COVID 19 has led to the impracticality and impossibility to perform such contractual obligations, and no alternative way is available to them for obeying such obligations.


Grounds for Invoking FM Clause·     

  •   Temporary Unavailability –The subject matter of the contract, either a person or an object that is fundamental to render the performance of the contract is temporarily unavailable. Time is the essence of such contracts. In Play Larga,[26] due to the outbreak of war, the Cuban Govt. denounced any trade with the Chilean Government. However, the buyer from Chile invoked FM clause containing expression ‘temporary interruption’ which extended to 30 days. The court held that such ‘temporary interruption’ cannot be subsumed with this catastrophic event because an extension of time was incomprehensible. Similarly, in various commercial contracts like supply contracts, services, and outsourcing agreements, the inevitable consequence is a failure to discharge contractual obligations owing to non-availability of the subject matter of the contract[27] even at exorbitant prices,[28] where an agreement was to deliver the goods at a particular time. Mere temporary interruption without a time constraint cannot be invoked.[29]However, in agreements of Computer and IT, Cloud Computing, automation services contract, it would be difficult to prove the direct causation because COVID-19 is not preventing them from any other alternative medium to provide services. However, if the FM clause contains specific exceptions like a power cut failure, back-up arrangements, [30] it can be beyond the reasonable control of the supplier.·      
  •  Failure of Specific Sources – If the subject matter of the contract is obtained from a specific source that became unavailable owing to no fault of either party, the FM clause can be invoked, for example, the deteriorations of the corps.[31] For instance, 70% of the coffee produced in India is exported, and Italy is one of the major importers. In such circumstances, where coffee could not be produced owing to lockdown measures, the exporters can claim that the subject matter of contract to not be available, and cannot be arranged through any other medium, even with extra-ordinary efforts in the wake of COVID-19 outbreak, since the production of the coffee is a fundamental essence of the contract, and thus FM is validly invoked.·       
  • Method of Performance – Due to COVID-19, Gateway Terminal, India’s biggest container terminal has invoked FM Clause,[32] because due to lockdown, all terminals have not been operation. In such circumstances, where the availability of terminals for offloading stock is fundamental to the contract, this does lead to the impossibility of the contract, where the performance cannot be rendered through any other medium available.[33] With regards to Commercial Contracts like in terms of distribution; in Peter Dixon & Sons Ltd. v. Henderson, Craig & Co. Ltd.[34], during WWI when British Ships were not available, foreign ships could have made available at an increased freight, the party couldn’t invoke the FM clause. For example, in supply and distribution agreements, any imports from China, an epic-center of the pandemic, would not be avowed owing to a total prohibition of transport mechanism by Indian Govt. Since, the impact could have been foreseen by the suppliers in China, it is flexible for them to invoke FM by relying on impossibility.·  
  •  Illegality On account of any amendment or enactment of any new legislation which may fluster the purpose of existing contracts owing to illegality, the contract may be rescinded. Any agreement cannot be acted against the law.[35] Govt. of India invoking Section 51 to 54 of Disaster Management Act, 2005 and Section 3 of Epidemic Disease Act, 1882 to override any laws in specific circumstances like rental obligations towards landlords is justified. In such rent agreements, the landlords cannot force tenants to obey the contractual obligations. Also, if the supply of medicine has requisitioned for public services in India, and any amount of export from India is strictly prohibited, the contractual obligation may be discharged.[36]

Pressure Points and Drafting Solutions

The FM clause is a scheme of civil law,[37] and thus, its scope is dependent on the construction, language, and wordings of the contract,[38] which gives rise to disputes and claims with respect to a specific set of facts. The FM can be covered in different shapes and can be flexible, as may be construed by the parties in the contract.  Therefore, it is pertinent to include FM clauses in the widest sense as to incorporate unforeseen risks like COVID-19, and to decide the fate of the enforceability of the contract thereon. A commercial contract is to be interpreted in a manner which gives business efficacy to such contracts,[39] and thus it is necessary to include a tenet of different measures in FM clauses. Following are some drafting solutions that may be feasible to be incorporated within the contract to avoid the liability

1.     Whereas Clause: Under English Law, it is assumed that when a party entering into the contract, they are deemed to have consented to the risks associated with the contract, even though the circumstances change. However, incorporation of ‘whereas clause’ in the contract highlights the intention of the parties, and provides a good example of a muddled meaning.[40] This clause serves as an interpretative guide to further clauses, and the contract in a whole.[41] During this pandemic, a clause may allow a party to avoid contractual obligations if significant market circumstances change. This clause is not substantive to bestow relief, and thus, must be followed by some clauses like hardship clause, MAC clause to gain relief.

2.     Use of Express Conditions along with a Hardship Clause: The principle to apply express conditions in a contract is pertinent because of a robust trend of adhering to strict compliances to express conditions.[42] For instance, a party may incorporate a clause ‘right of parties when significant market conditions changes’ in which circumstances like COVID 19 can be encapsulated, and the party may decide relief on whatever basis like renegotiation, adjustment, or any hardship clause.

3.     Material Adverse Change [“MAC”]: MAC clause is generally used in the context of Mergers and Acquisitions but can be used in the contract of sale of goods. MAC is a clause which highlights that if there is a significant material change in business, the affected may terminate the contract.[43] Alternatively, the clause could provide for renegotiation, and after the failure of renegotiation, the adjustment clause by the court can be rendered. Since, largest stock exchanges of the world hitting circuit breakers, a downturn in the whole sectors leading to MAC in the businesses across the world in the wake of a pandemic – is the safest to incorporate the MAC clause.

4.     Hell or High Water Clause: In this clause, the parties agree that regardless of a dramatic change of circumstances, the obligations are paramount duties to perform the contract, and thus making payment even on the occurrence of impossible events. It is mutually agreed that no party can obtain relief due to a substantial change in the contract

5.     Renegotiation and Adjustment Claims: On the occurrence of the supervening event, it is likely that the party would like to renegotiate amongst themselves. Therefore, re-negotiation and adjustment claims through a price adjustment variance, the appointment of a third person as an agent, escalator, or de-escalator clause are suggested.

Conclusion

Amidst the outbreak of COVID-19, the invocation of FM, and the doctrine of frustration are practical and probable in all aspects. The doctrine of Frustration has been narrowly applied, and the courts have been reluctant to bestow relief thereon. This simulates an understanding that parties may renege the contract on the grounds of the FM clause incorporated within the agreement. It would holistically depend upon the construction of the contract as to pandemic like COVID-19 can be assimilated within the explicit or implied meaning of the contract. Therefore, the drafting of such an extensive clause is a safe approach. In the future, parties may incorporate a set of clauses relieving themselves from the consequences of such outbreaks.


[1]Forum Bhatt, Inox Joins PVR To Invoke FM, BloombergQuint  (Apr. 08, 2020, 3:57 PM), https://www.bloombergquint.com/business/inox-joins-pvr-to-invoke-force-majeure

[2]M. P. Ram Mohan et. Al., The doctrine of frustration under section 56 of the Indian Contract Act, 4 Ind. L. Rev.  85, 89-90 (2020).

[3] Davis Contractors Ltd v. Fareham Urban District Council, [1956] 3 AC 696 (Eng.) (‘Davis’).

[4]Sea Angel,[2007] EWCA (Civ) 547 (Eng.).

[5] Frederick Pollock & Dinshaw Mulla, Indian Contract Act and Special Relief Acts 323 (11th ed. 1990 )

.[6] Kesari Chand v. Governor-General in Council, (1949) ILR (Nag.) 718 (India).

[7] AIR 1954 SC 44 (India).

[8]Id.

[9]Balwinder Singh v. State of Punjab,  (2017) 185 PLR 356 [16] (India).

[10] (1960) 2 SCR 793 (India).

[11]Dharanjamal Gobindram v. Shamji Kalidas, AIR 1961 SC 1285 (India).[12]Davis, supra note 3

.[13]British Movietonenews Ltd. v. London and District Cinemas [1952] AC 166 (Eng.); Tsakirog- lou & Co. Ltd. v. Noblee Thorl G.M.B.H [1962] AC 93 (Eng.); J. Lauritzen A.S. v. Wijsmuller B.V. (The Super Servant Two) [1990] 1 Lloyd’s Rep. 1 (Eng.).

[14][1647] EWHC KB J5 (Eng.); 82 ER 897 (Eng).

[15] FM and Frustration 45 (Ewan McKendrink eds., 2nd ed. 1995) (‘Ewan’)

[16]Nicholas, FM and Frustration, 27 Am. J. Comp. Law 231 (1979).

[17]Schmitthoff’s, Export Trade 199 (9th ed. 1990).

[18] Ewan, supra note 15, at 06.

[19] Nathan M. Crystal & Francesca Giannoni-Crystal, Contract Enforceability During Economic Crisis: Legal Principles and Drafting Solutions, 10 Global Jurist [i] (2010). (‘Nathan’)

[20][1970] 2 Lloyd’s Rep. 21.  (Q.B.) (Eng.).

[21] Krell v. Henry [1903] 2 KB 740 (Eng.)

[22] Karl Ettinger v. Changandas,  [1916] 40 (Bom.) 301 (India).

[23] Energy Watchdog v. CERC, (2017) 14 SCC 80 (India) ( ‘Energy’).

[24][2004] 1 HKLRD 754 (H.K.).

[25]Tamplin SS Co v. Anglo Mexican [1916] 2 AC 397 (Eng.). (‘Tamplin’).

[26] [1983] 2 Lloyd’s Rep. 171 (Eng.).

[27][1989] 1 Lloyd’s Rep. 148. (Eng.).

[28]Tennants (Lancashire), Ltd. v. C. S. Wilson and Co. Ltd. [1917] AC 495 (Eng.)[29] Tamplin, supra note 25.

[30]Peter Savile & Sanjay Pritam, FM and Cloud Computing Projects (Nov. 06, 2012),  https://www.internationallawoffice.com/Newsletters/Tech-Data-Telecoms-Media/United-Kingdom/RPC/Force-majeure-and-cloud-computing-contracts

[31]Couturier v. Hastie, [1856] 5 HL (Cas.) 67 (China)

.[32]Manoj P, Gateway Terminal, India’s Single Biggest Container declares FM (Mar. 29, 2020), https://www.thehindubusinessline.com/economy/logistics/gateway-terminals-indias-single-biggest-container-terminal-declare-force-majeure/article31190856.ece#

[33] Energy, supra note 23

.[34] 1919(2) KB 778 (Eng.)

[35] Indian Contract Act, Act. No. 9 of 1872, Imperial Legislative Council (1872) (India).

[36]Tennants (Lancashire), Ltd. v. C. S. Wilson and Co. Ltd. [1917] AC 495 (Eng.).

[37] Ewan, supra note 15, at 08.

[38] Energy, supra note 23.

[39]Id.

[40]Block Gertrude, Consider the Whereas Clause, 68 Wis. Law. 36, 37 (1995).

[41]UNIDROIT Principles, Preamble, http://www.unidroit.org/english/principles/contracts/main.htm.

[42]Nathan, supra note 19.   

  [43]Timothy R. Donovan & Jodi A. Simala, Successful Partnering between Inside and Outside Counsel §41.32 (2010).

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